Lessons from Recession

Lessons from the Great Recession

by Chad Hull, Charlie Crowley and Chris Chapman Managing Directors, Investment Banking Boenning & Scattergood, Inc.

It happened so fast! One day, we had record low unemployment rates and very strong measures of banking industry health compared to historical averages (record earnings, strong capital levels and superb asset quality metrics). In a flash, large segments of the economy were shut down by the scary presence of an invisible enemy that upended the way we had always worked, learned and played. In addition to the stress related to health and safety concerns, there are widespread concerns about unemployment and whether businesses, large and small, will be able to survive. The nation’s bankers, as always, have been on the front lines in helping to ensure that businesses and consumers can still function and keep our economy alive.

Many industry observers thought that the Great Recession of 2008-2009 was no more than a once-in-a-generation phenomenon in terms of severity. Unfortunately, bank leaders today need to dust off the playbook and examine what they and others did right and wrong, navigating their way through the Great Recession and rebuilding their businesses in the challenging years afterwards.

Of course, there are significant differences between the Great Recession and the COVID-19 crash. The Great Recession was triggered by a variety of factors, including steps by Congress, Freddie Mac, Fannie Mae and rating agencies to create a more highly leveraged mortgage finance system, with nothing-down loans and cash-out refinance deals that, in hindsight, were very unwise. Mostly, the problems that ensued were the result of a cracking of the widely held, multi-generational view that housing (if not most forms of real estate) would always hold its value, thereby allowing for a high degree of leverage. Some of the Wall Street banks were facilitators of ill-conceived derivative products and securitizations, and certain Wall Street firms themselves were overly leveraged and unable to handle the liquidity squeeze that resulted from the credit crisis. Because of the many complex issues leading to the housing bubble and the Great Recession, most people (in D.C. and on Main Street) did not have a good understanding of the facts and tended to incorrectly blame banks as being the source of the economy’s problems. Although the government’s investments in banks under the TARP program actually generated a positive return, the banking industry was tarnished by having received expensive government “bailouts.” This time is different. Banks certainly did not cause the coronavirus problems, and the government was largely responsible for putting the economy into a medically induced coma in order to prioritize the safety of our citizens. The hope is that the public health issues can be controlled well enough to allow the economy to bounce back from this recession relatively quickly and decisively, as opposed to struggling through a protracted and uneven recovery, potentially requiring dramatically more governmental and taxpayer assistance than has already been supplied. Only time will tell, but the nation has never been through an immediate economic deep freeze like this.

Like the Great Recession, this period obviously creates a tremendous amount of uncertainty for banks. Unlike the Great Recession, however, the media’s portrayal of banks’ involvement is trending more favorably today. Hopefully, the majority of people will realize that banks are working with customers and the SBA to help keep businesses and households afloat economically. Nevertheless, challenges abound. Stock prices have already been hit hard, as investors brace for darker days ahead. Loan losses for the industry are widely expected to increase, with the result that earnings are likely to be down and capital is likely to be stretched at least to a certain degree (though industry capital levels were dramatically higher this year than at the outset of the Great Recession). In challenging times like these, bank leaders will certainly be under pressure and will be presented with great opportunities to shine. In most cases, we believe that the lessons learned from the Great Recession will help the nation’s bankers today.

Reflecting on our own practice of advising community banks, we have been fortunate to have worked with many outstanding banks and bankers over the years, through good environments and challenging ones. With that experience in mind, we offer the following suggestions from observing successful clients as they worked through the Great Recession and its aftermath:

Maintain focus on ALL of your stakeholders. The best bank leaders instill in their organizations a culture of serving several constituencies – employees, customers, shareholders and regulators – recognizing that the stakeholders are interconnected.

A bank that takes good care of its employees will find that its employees provide excellent service to its customers. Regular and open communication with regulators is necessary to keep them

continued: Lessons from the Great Recession

as an ally rather than an adversary. It is this awareness, along with prudent risk management, that can position a bank to potentially deliver acceptable risk-adjusted returns to shareholders. For banks to emerge stronger from a difficult period, it is critical that they not lose focus on this broader mission. Take your medicine. If you have loans to downgrade or losses to recognize, it is generally prudent to do it sooner rather than later. In the early stages of a downturn, it is virtually impossible to know exactly which sectors of the economy will bounce back quickly, which will suffer the longest and how deep charge-offs will ultimately go. Whether you are in a CECL framework or using your historical methodology, the past experience in this case holds few clues as to what your actual losses will be. Of course, you need to be able to justify your decisions to auditors and regulators, but an extra-cautious posture is seemingly more appropriate at the current time than a drip-drip-drip approach.

Communicate in an honest and straightforward manner

about your financial results. After the Great Recession, a huge number of banks bent over backwards to focus on pre-tax, pre-provision earnings, almost acting as if the loan loss provisions did not matter. There are contexts where it is reasonable to discuss PTPP and other trends, but losses are losses, and the net income or loss as well as its effect on book value are of critical importance to investors. Demonstrate that you have a handle on all aspects of credit administration and risk management, and provide a meaningful amount of information about loan concentrations and other matters. If shareholders hear tough news directly from you, they may not come up with additional, pessimistic assumptions on their own. Maintain an appropriately strong capital position. Everyone in the industry would be wise to remember the “Capital is King” mantra. That does not mean that you need to have a tremendous amount of excess capital, which will drag down your ROE levels, but it does not hurt to maintain an extra margin of safety until you have greater clarity on your asset quality and business outlook. Most banks will not want to consider raising equity capital at current valuation levels if it can be avoided. We would argue that it is often preferable to shrink your balance sheet a bit if you feel that you need to improve your capital ratios marginally. Issuing debt may be an attractive alternative and the debt markets have been receptive lately to bank issuers, but market conditions can shift quickly, especially during a crisis. Banks with a plan can move decisively when needs and market opportunities align. In the near term, it probably makes sense for most banks to stay cautious about stock buybacks, even though your stock may, in hindsight, have represented a relative bargain. On the other hand, we have observed that shareholders strongly prefer that the board maintain the bank’s current dividend level if possible. For what is, in most cases, a relatively modest amount of money, a bank can send the market a strong signal of confi

dence in its outlook.

Consider growth opportunities, including selected acquisi

tions and talent additions. If your bank may have been interested in acquisitions before the recent market turmoil, you should not necessarily rule out potential opportunities, and you should continue to cultivate relationships with prospective partners. Both parties will obviously need a higher degree of wariness with respect to credit diligence in the near term, but that does not mean that a deal cannot materialize. Some very attractive deals for buyers and sellers took place in the aftermath of the Great Recession. Particularly, if there is a stock component to the deal, a given seller may be able to take a buyer’s stock at somewhat depressed levels and ride back up with the buyer when market conditions improve. Whether or not you consider acquisitions of other companies, this may be a great time to add skilled bankers that will help you in the years ahead.

Adopt a growth mindset from a customer standpoint. You can either sit around with a “woe is us,” defensive mindset, or you can adopt an entrepreneurial approach and find new opportunities. In the midst of the Great Recession, some of the large, regional banks were kicking out all customers in certain SIC codes or dramatically reducing commercial real estate exposure. As a result, many long-time, solid customers were abandoned during a difficult time. Nimble community banks with a growth mindset ended up with some high-quality, new customers that may not have been previously considered potential customers. History does not always repeat itself, but there will certainly be some attractive, free agent targets this time around as well.

Nobody wanted to be in this position from a health or economic standpoint, but we are confident that opportunities to strengthen your business will appear as we all work through the current market turmoil. By drawing on the lessons learned from the Great Recession, many of the nation’s banks will emerge as even stronger companies in the years ahead.

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